Mutual Funds in a Low-Interest Rate Environment

Over the years, the popularity of mutual funds has gone up by several notches, with retail investors investing in them to build a corpus for various life goals. While several categories of funds have given impressive returns, investors often question their utility in a low-interest rate environment.

With the Reserve Bank of India (RBI) pausing key rate hikes in subsequent monetary policy meets, there’s a growing consensus about rate cuts in the coming days. So, how will funds perform in a low-rate environment, and should you invest in them in such a scenario? Let’s find out.

What is a Low-Interest Rate Environment?

A low-interest rate environment is when the prevailing interest rates are relatively lower than historical averages. In such an environment, borrowings become cheaper. The primary goal of implementing a low interest rate is to stimulate economic activities and encourage borrowing and spending.

Bond Funds Expected to Do Well

Debt funds, especially bond funds, are expected to perform well when interest rates are low. Bond funds invest a significant portion of their assets in bonds issued by government and corporations. Bond prices and interest rates are indirectly proportional. It means when interest rates are low, bond prices are high, and vice-versa.

In a low-interest rate regime, bond prices increase. This, in turn, increases the fund’s net asset value or NAV, which potentially translates into higher returns for investors. Also, in a low-rate environment, the yield or the interest income from fixed-income securities in mutual funds goes up. This results in potentially higher gains from mutual funds.

Impact on Equity Funds

Equity funds also benefit from a low-interest rate regime. When interest rates are low, borrowing becomes less expensive for companies. This, in turn, can boost a company’s performance and profitability. This enhances returns from equity mutual funds and increases your portfolio’s value.

On the other hand, when interest rates rise, borrowing becomes expensive for companies, and it hurts their profitability. This brings down the returns from equity funds.

Investing Mantra in Mutual Funds When Interest Rates Are Low

Investing in mutual funds when interest rates are low doesn’t need to be any different. The basics remain the same. Ensure:

Optimum Diversification

Make sure to diversify well across funds - debt and equity. This ensures you capture the upsides well and benefit from both these funds. The right dose of equity and debt offers stability to your portfolio in the long run.

Regularly Review Your Portfolio

Mutual fund investment is not a one-time exercise. You need to review your portfolio regularly and ensure your investments align with your goals. Rejig your portfolio if necessary to take advantage of the upside during bull runs and protect the gains from eroding when markets are down. Don’t act under impulse and seek help from a professional when in doubt.

In Conclusion

As evident, both debt and equity funds tend to benefit from a low-interest rate regime. With inflation peaking and major central banks, including the RBI, hinting at lowering rates in the coming days, we could be heading towards a low-interest rate regime. Stay invested and reap the benefits!